Woodward, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Woodward, Inc. is a U.S. based independent designer, manufacturer, and service provider of control solutions for aerospace and industrial markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Woodward’s core business is designing, manufacturing, and servicing energy control and optimization solutions for aerospace and industrial markets.

Business Overview

Woodward operates in two primary segments: Aerospace and Industrial.

Aerospace:

This segment focuses on providing systems and components for aircraft engines, airframes, and other aerospace applications.
It caters to both commercial and defense aerospace sectors.
Products include fuel delivery systems, actuation systems, and sensors.
Revenues are derived from sales to original equipment manufacturers (OEMs), aftermarket sales, and support services including repair and overhaul.

The company is benefiting from the rise in commercial air travel.

Industrial:

This segment serves markets such as power generation, transportation, and oil and gas.
It produces systems and components for engines, turbines, compressors, and related applications.
Revenues come from providing products to original equipment manufacturers, as well as from selling products to aftermarket customers and providing support services.

Woodward’s Industrial segment is seeing increased demand from the natural gas industry, which is pushing higher prices and growth.

Moat Assessment

Moat Rating: 2 / 5

Limited Intangible Assets: Woodward has some intangible assets, such as its technology for aircraft engines, but they are not strong enough to command high-pricing power in the competitive landscape.
Some Switching Costs: For certain complex systems where integration is needed, there can be some switching costs but they are relatively small.
No Network Effects: The company does not benefit from network effects.
Cost Advantages: Limited: Woodward aims to be the lowest cost provider, but many competitors try to do the same. The company’s advantages in this area are good but not great.

Overall, Woodward possesses a narrow moat derived primarily from its specialized expertise and long-standing relationships with some customers, especially in the aerospace sector. However, those are vulnerable to intense competition.

The company is more of a supplier than a brand, and doesn’t have as much pricing power. While there is some stability with government contracts, competition is still high.

Risks to the Moat and Business Resilience

Supply Chain Issues and Raw Materials: Woodward relies on suppliers for components and raw materials, so any disruption in its supply chain and increases in input costs can hurt margins. For example, in their latest quarterly filing the management noted that they have “experienced significant supply chain disruptions and inefficiencies.” This causes higher costs and makes it harder to deliver products on time.
Intense Competition: Woodward faces competition from numerous companies, both large and small, which can hurt pricing power and profitability.
Technology Disruption: Rapid technological advancements could reduce demand for its traditional products, as well as require increased R&D spending. If companies are slow to adapt to technological change they will become less attractive to customers.

Management has been struggling with supply chain issues and inflation for a while. And now it is having issues with labor as well.

Despite these risks, Woodward possesses a few key factors that make the business resilient:

Long-Term Contracts: Multiyear contracts, especially with the U.S. government, provides a measure of stability and protection against pricing fluctuations.
Exposure to Multiple Industries: Diversifying revenue streams across commercial, defense, and industrial sectors helps mitigate risks associated with specific industries or economic cycles.
Focus on Aftermarket Sales: Recurring revenue stream from parts, repair, and other services increases the resilience of the business.

Financial Overview

Woodward’s financial performance reflects its position as a key supplier in its market. The recent quarterly financial statements show good revenue growth but show some issues that are affecting the business. The information is primarily taken from the 2023 annual 10K report, as well as recent 10-Q quarterly fillings.

Revenue Growth: Total sales for fiscal year 2023 were up 14% to $2.88B, from $2.54B in 2022. In particular, aerospace segment sales increased 15% to $1.77B, and Industrial segment sales increased 12.2% to $1.11B. Both segments are growing.

In the 9 months ended June 30 2024, Aerospace revenue was up 18.6% and Industrial revenue was up 16.3%, again showing good growth in both segments.

Gross Margin: Gross profit as a percentage of revenues has decreased to 24.9% in the recent quarter of 2024 from 26.4% in the same quarter of 2023. This is primarily due to the increased costs of parts and manufacturing and increased labor.
Net Income & Margin: Net income for the first three quarters of fiscal 2024 was $303M, compared to $187M in the first three quarters of 2023. In fiscal year 2023, Net income was $172.2M, which is lower than the $208.7M generated in fiscal year 2022. This decrease in income as a percentage of revenue is due to rising costs.
Operating Cash Flow: For the three quarters of fiscal 2024, Free cash flow was $275 million, compared to $29.4 in the first 9 months of fiscal 2023. The drastic increase in cash flow is due to improved profits and a focus on working capital improvements.
Capital Allocation: Woodward uses a good portion of its free cash flow to buy back shares. They have bought back a total of $259.3 M worth of stock in fiscal year 2023. In the 9 months of fiscal 2024 they bought back 127 M of stock. Management also uses the cash for R&D and paying down some of its debt.
Strong Balance Sheet: While net debt at the end of 2023 was $441M, cash was $266M, leading to a net debt position of $175M, which is manageable, especially when compared to the total value of the company.

It is key to note that Woodward has a relatively low amount of long-term debt, but has increased its borrowing in the form of short-term revolving credit facility.

Understandability Assessment

Understandability Rating: 3 / 5

Woodward’s core business is relatively easy to understand, as they operate mainly as a manufacturer and a supplier. However, fully comprehending all the complexities in their operations and the intricacies of the market segment is difficult to do, due to all the details needed to properly analyze the industry, and the business itself. Their business activities are generally not difficult to understand, but the financial statements can require careful analysis due to complicated lease accounting, multiple acquisitions, and the many non-operating items that could confuse the reader.

In this case, I have rated the company 3/5, which means that some effort is required to understand this business.

Balance Sheet Health Assessment

Balance Sheet Health Rating: 4 / 5

Woodward has a manageable level of debt and has a history of consistent cash flows.
They are managing their leverage effectively, particularly in relation to assets and equity.
The recent increase in debt to finance the Scottish & New Castle acquisition is something to be mindful of but seems to be manageable for the time being.

Therefore, the company has a healthy balance sheet that provides some flexibility in operating the business. The main concern is the growing level of debt.

While the balance sheet is overall healthy, the rising debt will need to be watched closely as it can affect the business’s long-term performance.

Recent Concerns/Controversies and Management’s Perspective

Management has been very vocal in its recent earnings calls of problems related to supply chain, labor, and overall inflationary pressures that are hurting the margins. They are confident they will be able to increase prices and gain efficiencies to offset the pressure.

In their earnings calls, Management has been focused on these items:

Supply chain and inflation: Management discussed that the supply chain is still unstable, and they are seeing higher labor costs. They believe they will be able to handle it through strategic pricing and by increasing production.
Inflation: The company has been successful in passing through rising costs to customers, and expects this trend to continue in future quarters.
Acquisition: Management has focused on the integration of the recent acquisition and has been highlighting the benefits they will get from the new business.
Share repurchases: Woodward has been actively repurchasing shares to increase value for shareholders.
Debt: Management has stated that they intend to continue to pay down debt to make the balance sheet more conservative.

The main points from the management is that they are aware of headwinds, but are confident that their management skills and their business will be able to handle these problems.

Overall, WWD has a narrow but relatively stable moat stemming from its unique position in both aerospace and industrial segments, some long-term relationships with its clients, and some benefits from its proprietary technology. The company’s financials are strong, but could be a bit better. Management seems committed to improving profitability and handling current risks.